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Has Boyd Reached Bottom?

A casino sale could turn this company from broken to bargain.

When Boyd Gaming(NYSE:BYD) announced its first-quarter results three months ago, there were noticeable signs of a deceleration in the firm's erstwhile robust Las Vegas locals business. Seven of Boyd's eight locals casinos turned in a flat performance for the quarter, while the newly opened South Coast was responsible for virtually all of the upside progress in the key segment.

Unfortunately, judging by Tuesday's soft second-quarter results, things have now gone from bad to worse. It seems that "flat" has suddenly given way to "declining," and the projected cash flows of the South Coast resort simply haven't materialized yet. In fact, rather than being a key growth driver, Boyd has decided to sell the once promising property -- even though it has only been open for seven months.

The surprising news exacerbated fears of a slowdown and extended a painful slide in the stock that began picking up steam in late April. Since Boyd reported its first-quarter earnings three months ago, the shares have retreated from a peak of $54 to a new 52-week low below $35. At this level, long-term investors willing to look forward rather than backward have to like their odds.

Second quarter a bustFor the first time in six years, there has been a significant capacity increase in the Las Vegas locals market -- and its impact is already being felt. For the period, adjusted EBITDA in Boyd's locals segment ticked up 4%, on revenues that rose 16% to $264.4 million, but those gains were once again skewed by the addition of the new (and now discontinued) South Coast resort

As suspected, the opening of rival Station Casinos' (NYSE:STN) high-end Red Rock Station has siphoned some business away from Boyd's nearby casinos -- most notably Suncoast, whose revenues and EBITDA tumbled 11.1% and 23.3%, respectively. Elsewhere, the Orleans Casino reported a double-digit drop in earnings, and the flagship Sam's Town resort in Boulder Strip also posted weak numbers.

Meanwhile, the firm's collection of downtown casinos (which relies heavily on Hawaiian tourists who book trips through Boyd's own travel agency) posted its second highest Q2 results ever -- unfortunately, the strongest came in last year's second quarter.

On the positive side, Boyd's central region -- which includes a handful of riverboat casinos from the Midwest to the Gulf Coast -- continues to show steady progress. Following the completion of a $170 million expansion project, the Blue Chip in Indiana delivered solid gains. At the same time, New Orleans' Treasure Chest casino nearly tripled its EBITDA, despite the reopening of Harrah's(NYSE:HET) downtown resort in February.

Boosted by those gains, revenues in the central region jumped 12% for the quarter to $245.9 million, while EBITDA also climbed at a respectable double-digit pace. However, it wasn't enough to keep overall adjusted earnings from slipping to $0.47 per share from $0.52 a year ago -- snapping a streak of eight consecutive year-over-year gains.

Locals market not foldingWhile it is difficult to sugarcoat Boyd's second-quarter numbers, they are not the leading news story -- nor are they indicative of where the company is headed.

Despite alarmist talk of overheated housing in Las Vegas, there is little reason to believe that the underlying health of the locals market is in any real jeopardy. The recent 14% increase in available gaming positions will gradually be absorbed by an influx of more than 7,000 new residents who settle into the region every month.

To be sure, this process won't take place overnight, but there is unlikely to be any further significant capacity to come on line for the next several years.

Furthermore, as the population base swells to accommodate tens of thousands of new workers and retirees, regulatory hurdles have limited off-strip casino development to previously zoned areas. This barrier to entry will help ensure that established leaders like Boyd and Station will continue to cash in on what is likely to be a growing supply/demand imbalance.

For its part, Station has also been battered lately on similar concerns and a recently lowered earnings forecast. However, management insists that the revised outlook is simply the result of higher interest expenses and not necessarily indicative of any sharp macro-economic-induced slowdown in the play of locals. (The fact that Station has cut its EPS estimates while maintaining its EBITDA guidance would support this argument.)

SouthCoast saleSo, why then has Boyd decided to yank the cord on the much-hyped South Coast after only a few months of operation? Good question.

Located just six miles south of Mandalay Bay on the southern fringe of the strip, the $600 million resort has a full complement of amenities needed to attract visitors living in the fast-growing southern suburbs, and even a few unusual attractions: a 16-screen movie theater, a 64-lane bowling center, and a state-of-the art equestrian center.

The resort was also billed as the first luxury casino encountered by Southern California visitors making the short drive up I-15. However, a major piece of infrastructure is still missing, and many doubt that the property will reach its potential until a planned interchange that has been delayed finally opens later next year.

Thus far, South Coast's early performance has been disappointing, with the property only generating $16 million in EBITDA during its first six months of operation. Boyd's decision to cut the ties so soon clearly suggests that management is unwilling to wait for the resort to reach its expected level of production.

As a result, the company has agreed to hand over the casino to Michael Gaughan (founder of the Coast Casino group) in exchange for the proceeds from the sale of his 17.7% (15.8 million shares) stake in Boyd. At Tuesday's close, that equates to a purchase price of approximately $576 million -- or a shade under the resort's $583 million price tag.

Though South Coast only delivered $16 million in EBITDA during its first two quarters, business should eventually pick up, and Gaughan has thrown out a ballpark annual EBITDA of $40 million this year. Using that figure, Boyd is unloading the property for roughly 14.4 times EBITDA ($576 million / $40 million) -- nearly double the 7.4 EBITDA multiple that the firm shelled out to acquire the Coast chain in 2004.

Of course, that calculation is overly simplified, but it does suggest that Boyd is getting a fair price to remove a large amount of uncertainty. The sale will also help shore up the balance sheet, and provide an injection of capital to help fund development plans elsewhere. At the same time, Gaughan's formal separation from Boyd will mean that the remaining Coast properties can be better integrated, and the elimination of Coast's corporate office will eventually lead to substantial cost savings.

Intriguing valuationAll things considered, much of the bad news at Boyd has been overstated -- and more than baked into the current stock price. And let's not forget, while the long-term outlook for the Las Vegas locals market remains attractive, Boyd does have an entire portfolio of other assets to fall back on. In fact, the firm's non-local casinos represent approximately half of earnings and nearly 60% of total revenues.

For example, the firm's joint interest with MGM Mirage(NYSE:MGM) in the red-hot Borgata continues to pay off handsomely. Aside from the highest per-unit table and slot wins in the Atlantic City market, the resort's brand new 85-table poker room has reportedly been packed to capacity around the clock -- except, of course, when a budgetary squabble led to a costly shutdown of Atlantic City's twelve casinos earlier this month.

And when the sprawling Echelon Place is finally up and running, Boyd will have the final piece of the puzzle in place, becoming the only gaming company on the planet to have a prominent position in all three Las Vegas markets -- locals, strip, and downtown -- along with strong contenders in Atlantic City, South Florida, and several key riverboat markets in middle America.

After plunging nearly 35% over the past three months, Boyd is now trading at one of the most compelling valuations in the gaming group. Here is a quick look at how the shares stack up against those of Boyd's major competitors:

Company

YTD Return

EV/EBITDA

PEG

Price/Cash Flow

Price/Book

Boyd

(27.9%)

8.5

0.9

7.4

2.8

Harrah's

(9.6%)

10.4

1.1

17.6

2

MGM Mirage

0.9%

10.5

1.1

9.3

3.2

Station

(20%)

12.8

1.3

9.7

8.9

The last time Boyd changed hands at this level was in 2003, just before the shares skyrocketed 162% the following year. By no means am I suggesting that the stock is set for a repeat performance, but for those looking to find a top-tier gaming firm at a reasonable price, now may be the time to get in the game.

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Fool contributor Nathan Slaughter owns shares of Boyd, but none of the other companies mentioned. Not even card counters can thwart the Fool's ironclad disclosure policy.